(Updates with Peretz comments)

JERUSALEM, April 2 (Reuters) - Defence Minister Amir Peretz has authorised the Israeli army to carry out limited operations just inside the Gaza border against Palestinian militants, Defence Ministry sources said on Monday.

Israeli Prime Minister Ehud Olmert has played down the chances for now of launching any major Israeli offensive inside Gaza, though he has not ruled it out.

Israeli security sources say Islamist militant group Hamas's armed wing has been digging tunnels and upgrading its rocket arsenal for a possible confrontation.

If carried out, Peretz's order could mark an escalation in Israeli military activity in the territory it withdrew from in 2005. Israel and the Palestinians agreed to a shaky ceasefire in the Gaza Strip in November.

Some militant groups have continued to fire rockets into the Jewish state from Gaza despite the truce. Israel says it is exercising restraint, but responded last week when ground forces fired on a rocket-launching squad near the border fence.

Defence ministry sources said Peretz has given the Israeli military the authority to operate a small distance inside the Gaza border area when needed to stop militants from digging tunnels and placing explosive devices there.

Peretz told reporters on Monday Israel would "not allow the continued strengthening and arming" of militants in Gaza.

During a visit to a military base near Gaza, Peretz said the Israeli military had the authorisation to hit Palestinian rocket squads. "The IDF (Israel Defence Forces) has the authorisation to deal with every attempt (by militants) to hit soldiers and every attempt to produce the means that can hit (Israeli) civilians," he said.

Last month Hamas's armed wing said it shot and wounded an Israeli utility worker near the border and fired mortars at troops in the first attacks by the militant Islamist group since the truce.

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